What is net working capital? Why should it be considered an investment that a firm must make to increase its future profitability?

Question

What will be an ideal response?

Answer 1

Every corporation maintains a stock of current assets and current liabilities to buffer the inflows and outflows of cash generated by the firm's business. The term working capital refers to the stock of current assets consisting of cash, marketable securities, accounts receivable, and inventories held by a firm at any point in time. By subtracting the value of a firm's current liabilities, which are the corporation's short-term debts and its accounts payable, from its stock of working capital, we arrive at its net working capital. To the extent that a firm can be managed with a smaller stock of net working capital, cash can be paid to shareholders. Thus, one goal of management is to run a corporation efficiently in order to minimize the need for net working capital.
Increases in net working capital are investments that a firm makes to produce cash in the future because they use cash that could otherwise be distributed to shareholders. If the cash that is invested in net working capital does not earn the weighted average cost of capital, it should be paid to the firm's investors.